Category Archives: Due Diligence

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The Merger Vergerjust returned from M&A East, perhaps the preeminent middle market acquisition event of the year in this part of the world. M&A East is put on by the Philadelphia chapter of the Association for Corporate Growth and is very well done and very well attended.

While most of the attendees come for the rich networking opportunities, there are also work sessions and presentations … actual “content.” The Merger Vergerattended one roundtable session dealing with the large role that the Buy-and-Build strategy and add-on deals are playing increasingly in the private equity world.

We noted a number of interesting or useful points:

The Buy-and-Build investment strategy has both the advantages and disadvantages of focus: wisdom, experience and increasing market power and multiple arbitrage on the upside; concentration and lack of diversity on the down side. Pick your poison.

Market fragmentation can be an important attribute of a sector appropriate for Buy-and-Build but it requires some perspective and caution (read “better due diligence):

Is fragmentation the result of incremental market development over time or some fundamental customer or sourcing requirement?

A market that has long been fragmented may have an entrenched fragmented purchasing process on the customer side, making the synergy potential of national footprint harder or slower to realize.

As fragmentation decreases through consolidation, multiples can skyrocket.

Once the fragmentation has been wrung out, where will the next generation of growth come from?

Add-on deals don’t have to smaller than the core operation although The Merger Verger notes that the integration can be more subtly complex with the egos of the newer larger company clashing with those of the smaller original company. We’re bigger and stronger than you. Yeah, but we were here first, doing fine on our own, thank you.

When doing add-on deals, the question of branding looms large. It is highly possible that a small local brand carries more value in its market than a larger, more visible one. Landscaping services was an example of this.

On the question of making acquisitions during economic downturns, most of the roundtable presenters felt that it was important to carry on. One presenter saw downturns as an opportunity to average down their purchase multiples.

Conversely, both presenters and attendees noted that many middle market sellers don’t pay that much attention to multiples; they focus on price. (Multiples do not affect a seller’s retirement plans; raw dollars do.) In that context multiples can get ugly in a downturn.

While the topic of integration was listed on the agenda, it got – as it often does – a short shrift. There is still this sense that getting through closing is the Win. It is not. The Vergerrepeats: you will have a vastly more predictable and successful outcome if you actively manage the “hows” of integrating your add-on deal:

How are we going to realize the strategic intent behind this deal?

How are we going to avoid the identified risks factors?

How are we going to keep the best producers of the target company?

Exactly how are we going to get our products selling through their channels?

How are we going to make their square product design (or production or management or culture or sales) peg fit into our round hole?

Seller-entrepreneurs like the Buy-and-Build strategy:

They believe the buyer better understands “their baby”

It’s easier to get buy-in on visions and plans and investment

If the deal involves contingent payments, they have more faith in the the potential payoff

“Buy-and-Build” just feels a lot more appealing than “Slash and Burn”

Buyers like the B+B strategy. Sellers like it too. It may not be for every PE firm but it’s here to stay.

Analysis: The Merger Verger recently conducted a Google search on “due diligence.” In approximately one half a second, 36 million results popped up. We took a quick look at all of them and found that of those relating to M&A 98.7% deal with legal and financial due diligence. Digging a bit further we found that of M&A results 93.4% offer the same information within one standard deviation.

Conclusion: even The Pinball Wizard could conduct a tolerable-good due diligence investigation into the legal or financial aspects of an acquisition.

Tommy can you see me?

But strategic and operational due diligence … well, that’s another matter altogether.

For less experienced acquirers, The Merger Verger worries that they may make inquiries about what due diligence to do only to be told not to worry about it, their lawyers and bankers and accountants have it all under control. “Okay, good,” they might reasonably say.

Unfortunately, that sad little exchange explains why so many deals fail … because legal and financial due diligence do not – as a rule – probe the strategic and operational issues that are the foundation of (1) making a sensible deal and (2) making it actually work.

It is one thing, for example, to know how a sales force is structured and how they are compensated and even which salespeople are the most productive but it is another thing altogether to know how the sales people sell and how they interact with the product design people or if the selling process requires a deep solutions orientation or merely efficient order taking. It’s all different.

Your lawyers and accountants can ask all the “what” and “who” and “where” questions in the world about your acquisition target but if your operations people don’t ask the “how” questions your deal is doomed. (The point here is not to besmirch lawyers or accountants but to face the fact that this kind of due diligence is outside their normal scope of work.)

Strategic and operational due diligence provide the information upon which a successfully closed deal becomes a successfully done deal.

It begins with understanding how you, the buyer, function and then asking the questions you need to know to understand how to make you and the seller function together. If you don’t have the time to develop the “how” questions or probe the answers or enact the solutions yourself, GET HELP. You will tilt the otherwise very long odds of acquisitions in your favor. The Merger Verger guarantees it.

About the Art: The original album cover from The Who’s rock opera Tommy and a detail of a 1951 Genco Tri-Score woodrail pinball machine (courtesy of Mystic Pinball, www.mysticpinball.ca)

Afterword: it’s probably not that great an idea to quote any of the statistics cited in the opening paragraph of this posting. We made them all up. “Illustrative fiction” from TMV!

In acquisitions, sales can be just plain hard.

The Merger Verger was conversing earlier today with a senior sales executive at a recently acquired technology service provider and the subject of post-merger sales came up. More than half a year into this deal, major sales issues were still causing trouble, down to the level of non-existent goals and undefined bonus formulae.

Hello! Who’s in charge here?

A big part of this challenge sounds like a failure of due diligence or, if known, a set of differing practical issues that got downplayed and dismissed. They shouldn’t have. Turns out that the differences were pretty fundamental… and obvious if one looked.

Here’s the landscape: The buyer and target are in parallel lines of business. There were good revenue synergies and cross-selling potentials in the deal. The companies’ reputations and statures in the marketplace were compatible.

Now the specifics of this mess could not happen with today’s CRM systems but the message is still relevant: God is in the details.

It’s hard for The Merger Vergerto determine from the available facts whence cometh a screw-up like this one but I see two possibilities: either (i) there was insufficient focus on the operational aspects of due diligence or (ii) there was reasonable data collection but insufficient analysis and findings based on that data.

A fair measure of due diligence is about gathering information. But much of it is about using information.

If you are an infrequent acquirer or new to the deal business, this is an absolutely critical lesson for you to take in.

Some due diligence is about making sure you have information that you, the new owner of a business, should have. An example would be papers relating to the target’s corporate formation. You get the data; you put it in a file; you forget about it. (This kind of information will come from the due diligence checklist supplied by your lawyers.)

Other due diligence is about confirming that you are getting what you pay for (and the corollary, that you are not overpaying for it). An example, here, would be a statement of aging accounts receivable. If the target has a third of its receivable stretching back to Moses’ time, you might want to rethink the price you’re paying. (This kind of information will come from the due diligence checklist supplied by your accountants.)

Lawyers and accountants provide essential guidance in the development of due diligence checklists. But much of the information derived from those lists has limited use or limited life to its usefulness.

Not so with the next form of deal information.

The final form of due diligence is about getting ready to own the new business. This is the area where Federal Mogul fell down. You must understand how the business works down to some very nitty gritty details and then apply those findings to shape how you are going to integrate the business.

In Federal Mogul’s case, they should have realized that the customer-facing requirements of the target could not be handled by their own existing CRM system. Knowing that, they could have avoided making an uninformed misstep in the integration process or reversed the move by integrating their own customer interface with the apparently more flexible system that T&N used.

Can their customer database handle non-US telephone numbers? It seems like an impossibly small item to worry about. But sometimes it’s not.

In words of two syllables or less:

Make sure you get the operational information necessary to know how to integrate your acquisition.

Once you have gathered the information, use it.

And … before you make big integration decisions, consider doing further due diligence. Closing day is not the end of information gathering … not by any stretch.

Acting quickly is generally the right approach when integrating two businesses. But don’t ignore the asterisk: act quickly … on good information.

About the Art:

The coining of the phrase “God is in the details” is attributed to German/American architect Ludwig Mies Van De Rohe. Despite having built some fairly impressive buildings including New York’s Seagram Building, Mies is perhaps best known for his Barcelona Chair (top), which he designed in 1929.

The Merger Verger is no lawyer so we don’t like to get too deep into the legal aspects of integration (hoping – in part – to set an example for lawyers not to get too deep into the operational aspects of integration) but once in a while we come across an article that draws attention to a topic that doesn’t get much attention in integration circles. So we highlight it.

One came to our attention recently on the risks associated with acquiring a company that does not comply fully with the Foreign Corrupt Practices Act. Goodyear did just such a thing with fairly expensive results after the dust settled and the non-compliance came to light.

The article lays out three core areas of attention:

pre-closing due diligence including a distinct anti-corruption compliance component,

post-closing audits to unearth things that might have escaped the rush of pre-closing investigation, and

There was a very interesting article in the Wall Street Journal last week about the trend towards acquisition predators becoming targets, in a process referred to as “a bid for a bidder.” For shareholders of the “winning” bidder, it is the opinion of The Merger Verger that this kind of transaction has “BEWARE” written all over it.

Let’s look at what happens and why it makes the old Verger nervous.

As everyone knows, you do not want to examine the process of making sausage too closely, so with a contrarian view, let’s start there. Sausage maker Hilllshire Brands Co. recently agreed to buy processed food company Pinnacle Foods Inc. That prompted a poultry company, Pilgrim’s Pride Corp., to look at Hillshire … and bid for them. That then led meat producer Tyson Foods to bid for Hillside also. Tyson got Hillside but the Pinnacle deal (Remember Pinnacle? They were the original target here.) was called off.

So what’s wrong with all that?

First, if Pilgrim’s Pride and Tyson were so interested in Hillshire, why hadn’t they bid before the Pinnacle deal was announced? Certainly Tyson – an experienced acquirer – knew beforehand basically what they were bidding for in Hillside but the whole process smells more of playing competitive defense than strategic offense. In situations like this, strategic rationale and thorough due diligence can go quickly out the window. And both of these deal attributes are cornerstones of a successful integration. You lose your focus on them or weaken their role in the deal process and your shareholders will pay. And pay.

Speaking of paying, is there any research on M&A that doesn’t point out how hubris and paying too much are key failure drivers over and over and over? And when is someone going to overpay most readily? When they think they are behind a competitive 8-ball or when the bidding is taken through several rounds. Sadly, there is no hero status for the guy who says, “Screw it; it’s gotten too pricey.”

There should be.

Which brings me to … The Verger’s Law:

The probability of deal failure increases by the square of the percentage change in price from the initial bid.

This posting is for the C-level executives out there who are doing (or thinking of doing) deals for their small or medium-sized businesses. It is about helping you prevent form from overshadowing substance. It is about details. PS: if details bore you, The Merger Verger humbly recommends your stepping down from the deal business ASAP.

The Merger Verger has seen just a ton of due diligence checklists over the years and found almost all of them wanting … including some that were just pathetic.

Why? Because they are not written by people who run businesses; they are written by people who advise businesses: lawyers and accountants.

Let’s be honest here: due diligence checklists are about the details, where God (or the devil) is. A lawyer can make a fine checklist for matters relating to corporate formation or past board meetings. An accountant likewise within his or her purview.

These lists are fine (essential, in fact) for ensuring that you get what you pay for. But when it comes to understanding whether a product is approaching an inflection in its growth curve or the production manager knows the difference between a kaizan event and a tsunami, they ain’t worth squat.

One of the painful truths of business is that once in a while you are right and it doesn’t become obvious until it’s triage time. Such is the case at HP, as its well-publicized acquisition of Autonomy Corp. (2011) has destroyed more shareholder value than a whole battalion of court jesters and Shakespearean fools. How could a board of directors ignore the clear and direct advice of its CFO? Because it had (past tense) a CEO on a mission.

And what does the board say to a CFO like Catherine Lesjak when the dust has settled? “Oh, gee, I guess you were right. Would you mind hanging around for a while and cleaning the whole freaking mess up for us? That would be great.”

Come on, really?

In a short but insightful article in CFO Magazine, there are some useful lessons for all of mergerdom. The Merger Verger offers an annotated copy of the article below:

A previous posting looked at the issues that can arise when acquiring a company with a long-time owner/founder or (even worse) an owner given to self-love … what the shrinks call a “narcissist.” Today is follow-up: some cautionary approaches to dealing with them because (ah, life) they are way too prevalent to ignore.

Long-time owners can bubble with positive pride about their companies but their management techniques can make it extremely hard to tweeze apart what they themselves have accomplished versus what the company has accomplished. Particularly if the seller/owner is retiring to Madagascar, this lack of clarity can become a big issue.

And narcissists can be enormously charming individuals. That can make spotting one a

real challenge. The Merger Verger is no shrink so I will turn you over to others smarting than me for more details on diagnosing or identifying them (see links below).

What I will do here is offer some suggestions and words of caution on dealing with them.

I was discussing an interesting acquisition situation the other day with a long-time business friend of mine. She was looking at acquiring small a privately-held company in the specialty logistics space as a launching pad for a roll-up strategy. Her target was a company with an amazing customer list and a stellar 40-year reputation. It was underperforming operationally, which offered rich efficiency upside. The owner (age 70+) was interested in retiring.

Sound fabulous? Dig deeper.

If you are involved in executing a roll-up strategy, sooner or later you will come upon a potential target where the owner is the founder and long-time “face” of the business. In such a case, The Merger Verger has three words for you:

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THE MERGER VERGER is a forum for exploring, sharing and commenting on the world of acquisition integration.

Here at The Merger Verger we believe that acquisitions CAN be made to work, that they can create superior returns, superior workplaces and superior opportunities for the people involved. And we believe that bringing thought, imagination, and communication to the process is the right alchemy for achieving that end.

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